Stocks tend to rise after the Fed starts to hike

Investing.com -- UBS told investors in a note Tuesday not to fear the Federal Reserve's expected interest rate increase this week, arguing that history shows stocks tend to hold up once a tightening cycle begins.

The bank expects the Fed to raise rates on Wednesday but said earnings growth, not the first hike, will remain the main driver of equities, and it kept its S&P 500 targets of 8,100 for year-end and 8,400 for mid-2027.

Across the 16 hiking cycles UBS identified since 1954, the S&P 500 rose an average of 10.8% in the year after the first increase, and "the market has thus far never entered a bear market in the 12 months following the start of a hiking cycle," strategists led by David Lefkowitz wrote.

They argued economic growth matters more than the hikes themselves, noting the ISM Manufacturing index's new orders component best explains post-hike returns.

With manufacturing still expanding and AI investment set to grow into at least 2027, UBS said the current backdrop looks more consistent with continued expansion than contraction.

The firm also said much of the valuation hit from tightening may already be behind the market, with the S&P 500's forward price-to-earnings multiple down to about 19.5 from 22 at the start of the year as the 10-year Treasury yield climbed toward 5%.

"We do not expect the kind of aggressive tightening cycle that characterized several previous inflation-fighting episodes," the analysts wrote, tying much of the inflation overshoot to temporary factors.

They flagged AI infrastructure investment as the biggest medium-term risk, but said far more tightening would be needed before financing becomes a constraint.

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